Alpha sees limited value in new ‘Lloyd’s Index’

The FT recently ran a story with the headline: New index seeks to peer inside Lloyd’s of London insurance market.

The article describes a new index designed by Insurance Capital Markets Research, a London-based analytical firm. The index seeks to provide a measure of the underlying performance of the Lloyd’s of London insurance market by using the listed shares of those companies with a presence in the Lloyd’s market (calculated and administered by Moorgate Benchmarks).

We are highly skeptical that such an index will prove to be useful in any meaningful sense, because:

(i) The correlation between Lloyd’s underwriting returns and listed equities is extremely low as this table shows:

(ii) Listed insurance companies demonstrate a very high level of correlation to the broader equity indices in which they appear, rather than to underwriting returns (largely due to the nature of their balance sheets and the proportion of profits derived from investment, rather than underwriting, activities);

(iii) Some of the businesses that will feature in the index have a presence at Lloyd’s that is too small, when compared with the whole, to be a meaningful driver of their economic returns (i.e. Berkshire Hathaway, Hannover Re, SCOR, etc.); and

(iv) There are dozens of market participants that are not listed and therefore will not be represented in the index.

In other words, the index seeks to generate correlation out of uncorrelated assets and misses the point that Lloyd’s is a market rather than a single insurance entity.